On Wednesday, the Federal Reserve decided to increase rates by another 25 basis points (one-quarter of a percentage point), amid speculation that the latest increase will be the end of the year-plus rate hike cycle.
The Fed’s latest move brings the Federal Funds rate to a range of 5% to 5.25%—and it now stands 5% higher than it was in January 2022, before the rate hikes began. “It’s been a relatively aggressive tightening cycle,” said BOK Financial® Chief Investment Officer Brian Henderson. “In addition to raising rates, the Fed is also letting securities roll off from their balance sheet, which has been tightening up financial conditions.”
Even with Wednesday’s increase, Henderson believes we’re getting closer to the end of the Fed rate hikes—at least, for now.
“They can hold rates here for a while to squeeze out inflation. Meanwhile, bank lending standards have tightened and they’re going to tighten more because of some of the instability in the banking sector that happened in March and April, which will also work to bring down inflation. Those factors all point toward waiting before hiking rates again.”
Full impact yet to come
Many economists predict that May’s increase will be the last for a while. Still, monetary policy tends to operate with a lag and will continue to have an effect, Henderson noted. “It can take up to 18 months for the rate increases to be felt in the economy—we haven’t felt the full brunt.”
The next Federal Open Market Committee rate announcement is scheduled for June 14.
But there’s a downside to a pause in rate hikes as well. While inflation has been coming down, it’s still above the Fed’s 2% target, Henderson said. As of March, inflation stood at 5% year-over-year.
The pace of rent increases is finally coming down, which should help consumers who have been feeling the double impact of high food and shelter costs, he said. However, the cost of services still remains elevated and Henderson expects that to persist while the labor market remains tight.
“Still, with inflation trending downward, it seems like the market is shifting toward a little bit more concern about growth from here,” he continued. “Economic growth has held remarkably well so far, as consumer spending and retail sales are still good, but manufacturing has been contracting.”
Credit crunch, recession worries
As banks tighten their lending standards even further, concerns of a “credit crunch” may only affect some types of lending, Henderson said.
“On the consumer side, I wouldn't be too concerned,” he said. “The rates are high, obviously, but I don’t see banks tightening up lending standards for homes, credit cards or other consumer loans. That’s not where the credit issues are.”
In terms of business lending, the concern is mostly around some areas of commercial real estate—not so much industrial properties and multifamily apartment buildings, but rather office buildings, particularly on the coasts, Henderson explained.
“That’s where this tightness is going to be, and it’s already been tight because the office sector never really recovered from the pandemic.”
Others worry that too much of an economic slowdown could put the country into at least a mild recession. Although gross domestic product (GDP) remains positive, some areas of the economy are suffering.
For instance, in the technology and communication services sectors, corporate earnings have been declining year-over-year, despite the fact that companies’ revenues are growing. Henderson attributes the decline to margin pressure, as rising costs have been eating into these companies’ profits.
Meanwhile, consumer and CEO confidence levels have been down for about a year. “The last time we saw confidence at these kind of levels, we were in a full-blown recession, but we’re not now, and the economy has hung in there very well,” Henderson noted.
Indeed, one of the surprises of the yearlong Fed rate hikes is how strong the economy remains. Henderson thinks the answer lies in the job market.
“We’ve had multi-decade low unemployment and that’s really where people are always concerned when thinking about the future. If money keeps coming into your bank account and you’ve got a job, you’re going to continue spending.”